Monday, March 30, 2009

Will The SDR Replace The Dollar?

The head of the Peoples' Bank of China has made headlines recently proposing that the IMF's Special Drawing Rights (SDR) replace the dollar as a world reserve currency. An excellent discussion of this issue has been put up by Brad Setser at http://blogs.cfr.org/setser. There are some reasons why it is unlikely without some other very big changes, and that indeed the idea rather conflicts with what has been Chinese currency policy.

The main problem is that despite being created to replace gold as "paper gold," the SDR is not a currency at all. It is strictly a unit of account used by the IMF, currently with a value based on a basket of the US dollar, the euro, the British pound, and the Japanese yen, with the German mark and French franc preceding the euro before it replaced them. Presumably an altered SDR that brought in some other currencies, presumably including at least the Chinese yuan/renmimbi, could serve as a better measure of global value, but unless the IMF starts actually issuing actual SDRs, there is no way it will serve as a reserve currency. As it is, even the reserves of the IMF in other currencies, measured in SDRs, is only $200 billion, likely to be inadequate for dealing with the emerging financial crises in various Eastern European and other "peripheral" countries.

The problem for China is that they have been pegging to the US dollar. They are becoming uneasy about the value of their dollar holdings, but a decline of the dollar would keep their exports competitive with other countries (besides the US), which seems to be a major concern of theirs. If they were to peg to the SDR, whatever is in its basket, they could damage their export competitiveness. As it is, while some countries used to peg to the SDR, very few do anymore, with one of the most recent to abandon doing so being Latvia, which switched to pegging to the euro, big surprise.

5 comments:

Pat Donnelly
said...

The PLA and EU seem to be realists when it comes to stimulus, viewing the USA agenda with concern as it is calculated to drop the $US by maybe 50% from where it is now. China shunned trade for centuries. It was forced to trade by the west. Like Japan it hates the contaminations caused by trade with the west. Massive tech transfers to them by the west will be good for 20 years and the exports foregone will not be missed by China, provided it can access raw materials cheaply. Given that the mines in China are less efficient than say Oz, it will be maximized domestically as a curb for unrest. Too many males? That or human waves.... So perhaps they will continue the peg to the dollar but they also recognize the dangers to them hence warnings to the USA.

I do not see China folding in on itself. The problem I think is that they have been trying to figure out their role in the world as they have expanded into it, and this bad recession that is hitting them pretty hard is really raising the questions very sharply. I suspect that there is a much more intense debate going on within China about what to do that we are not hearing that much of.

The labor theory of value is not absolutely correct, but China should show us that it is not a bankrupt notion. The great deflation is in fact the effect of very cheap labor. And it is labor that most of us have to offer. If the dollar is allowed to remain stable in relation to Chinese labor then the American middle class will (and already has) suffer because of it.

The only real disadvantage to the weakening dollar is the price of petroleum based fuel. All else will adjust very well if the dollar is weakened by subsidies on the bottom of the economy. The dollar denominated price of housing is the focal point of dollar value at present. Direct injection of money such as what was done in 2008 along with national health insurance are the way to go.

"You can take that job and shove it.

I ain't workin' here no more".

That is what increases wages. And as the money will be losing value then the people who have all of it need to figure out some way to "invest" instead of lending money to the government at 3%. (government creates money -- why would a lake borrow water?)

Taxation is what gives money its value. And sooner or later that mechanism will need to be asserted in a proper way. I would suggest a return to the tax code of 1978 without the real estate goodies. I would also welcome import tariffs as well as excise taxes on carbon based energy. But there are many ways to tax.

Devaluation for exporters is a sucker's game. Prices are competitive as long as the workers are unable to ask for a raise to get their real wages back where they were before the devaluation.

The gains in units sold comes straight out of the hides of the export workers.

As for the SDR itself, there is little use in it as long as it is based on several fiat currencies which could all be inflating or deflating in concert. Maybe this is why Russia has suggested including gold in the mix... it was in the SDR in the beginning.